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Tax Diversifying Your Retirement Income
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Tax Diversifying Your Retirement Income


While most people think of permanent life insurance as a way to protect the financial security of their families, it can also serve as a powerful retirement tool.

While most people think of permanent life insurance as a way to protect the financial security of their families, it can also serve as a powerful retirement tool.

Published in Economy & Finance , Business
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  • You’ve told me that saving for retirement is one of your primary objectives, so I’d like to discuss where your retirement income might come from. Because when it comes to money for retirement, the equation really has changed a lot in the past couple of decades. It used to be that people generally retired at age 65, and most died by the time they were 75. So the typical retirement only lasted about 10 years. Back then, when people were planning for retirement, they could count on Social Security, a traditional defined-benefit pension and maybe supplement a little with some personal savings to cover their basic expenses. Today, people today are living much longer – often well into their 90s and even 100s. So retirement can now last 30 years or more, and thanks to medical advances and healthier lifestyles, people are staying active and doing more well into their retirement years. That’s all great news, but it has big implications for how much money you need to accumulate before you retire. And to add to the greater amount needed, many of the sources for retirement income are reduced – and may not be enough. All of which means most people are finding they must increasingly rely on personal savings and assets. Let’s look at these other traditional sources for retirement income…
  • First: Social Security. Many people believe it’s a little shaky. Did you get your Government’s “birthday card” – 60 days or so before your last birthday? If you’ll look on the front page of your last statement – you’ll find this paragraph: In 2017 we will begin paying more in benefits than we collect in taxes. Without changes, by 2041 the Social Security Trust Fund will be exhausted* and there will be enough money to pay only about 78 cents for each dollar of scheduled benefits. We need to resolve these issues soon to make sure Social Security continues to provide a foundation of protection for future generations. You see, Social Security was never INTENDED to be the ONLY source for retirement, although many people today rely heavily on it. Will it be there for YOU? Will it be enough? In 2008 the MAXIMUM Social Security Benefit for a worker retiring at full retirement age was $2,185 per month. How far would that go in helping you live out your retirement dreams? And, of course, to top it off – if you have earnings while drawing Social Security, then your Social Security checks are taxed! I think we are HOPE Social Security will be there for us. The question is whether you want to DEPEND on it!
  • Several decades ago, people went to work for a large company – stayed there for their entire working lives, and were rewarded for their loyalty with a nice defined benefit plan check when they retired– which meant that no matter what happened to the stock market, the company had made a promise to pay so much money each month. Today, fewer pensions are offered by businesses for their employees. Only 1 in 5 people currently have pension plans, and that number is declining every year. Instead, retirement savings are less likely to be provided by employers (except for matching employee contributions to a 401(k) for instance) and more likely to be funded by employees themselves. A drawback to all qualified plans is that the IRS places dollar limitations on the amount of money that may be deposited annually. Thus, even highly compensated individuals may be unable to save as much as they would like in those particular tax-favored plans. So, clearly, you have to count on your own personal assets to cover a bigger share of your financial needs in retirement, and those needs are probably bigger than you think.
  • So how much will you need from all sources to retire comfortably? Most experts suggest you’ll need at least 70% of what you earned while working for each year of retirement in order to maintain your standard of living; some even suggest you’ll need 100%. The question is – how much do YOU want? What standard of living do YOU want to maintain? Retirement planning has three main components. I can help you with a retirement income estimate / analysis – which will entail 1) How much income will you probably NEED to maintain the lifestyle you want. 2) Then you estimate how much money you probably will HAVE from all sources 3) That leaves you with an amount you need to SAVE personally to make up the shortfall. I can help you analyze these questions – which you should review regularly. And when analyzing how much you should SAVE to make up for any shortfall, TAXES often play a significant role in decision-making.
  • I’ve asked many of my clients: If we were to devise the tax-perfect plan for saving for retirement, what would be the components? And they answer: 1) CONTRIBUTIONS would be Tax-Deductible. Would you like that? 2) ACCUMULATIONS would be Tax-Deferred. No Taxes as the money grows. That’s Good! 3) And DISTRIBUTIONS would be Tax-Free, as well! So, if I could offer you all three of those components, wouldn’t you like to participate?! Well, that plan doesn’t exist, unfortunately, but you can have two of these tax benefits. Which of these two you would choose may depend partly on where you think income tax rates are going.
  • DO you think tax rates are going UP – or do you think they are going DOWN?! Let’s look at this chart representing the history of income tax rates. You can see how high the TOP rates were – and much lower the top rate is today. What does that really mean for where you put some of your personal retirement savings? Let’s think about it this way – you have to pay taxes on something; would you rather pay taxes on the amount that has GROWN after the contributions? OR do you want to pay taxes on the contribution – while the GROWTH is income-tax free?! Part of this decision would depend on where you think tax rates are going. Do you think you’ll be paying more or less taxes in retirement? Conventional wisdom has often held that when saving for retirement, you should save as much as possible through defined contribution qualified plans today because they will help build a retirement fund for you in the future, while deferring taxes until retirement when you’ll be in a lower tax bracket. Will you be in a lower bracket? And what does that look like NOW?
  • Historically, people often deferred income at a higher tax rate on the premise that they would pay taxes at a lower rate when they received that income in retirement. Let’s look at an example of someone in 1979 or 1980 who deferred as much income as possible at the highest tax rate of 70% -- and they only had to earn $215,400 to hit that maximum rate. If that person had deferred as much income as possible – and, let’s say they were at the HIGHEST rate today of 35% when they withdrew that money, -- that was a TERRIFIC strategy – and great tax arbitrage. In addition, as you can see, there were 15 tax brackets. So if they could lower their adjusted income by even a LITTLE, they could reduce their tax burden. So at a 70% income tax rate, people were looking for every opportunity they could to defer taxes. Today – are we in the same situation? Our current top tax bracket is 35%. So if someone is deferred taxes today at 35% -- to MAYBE pay taxes in retirement at a HIGHER rate – if you think taxes might go up -- is that still the BEST strategy? So, the tax leverage that qualified savings plans once afforded has been reduced . That’s why ROTH IRAs have become so popular – many people believe they are in a lower tax environment than they might be later. Therefore, they are putting money into a Roth with after-tax dollars to be able to take it out income-tax free in retirement. (Note: I can provide additional information on a Roth IRA, if you are interested.) This does not mean that you should stop savings in your company’s defined contribution plan; it just means that there is less tax leverage than there once was.
  • Let’s go back to our discussion about the Tax Perfect Retirement Savings. Under today’s tax regime, you can have two of the three tax benefits. You can choose 1 & 2 - tax-deductible contributions and tax-deferred accumulations. But if you do THAT – then all the distributions (i.e. retirement income) are taxable. What types of retirement planning vehicles did we just describe? That’s right – qualified plans – which encompass company pension plans, SEPs, 401(k)s, keoghs, profit sharing plans, and traditional deductible IRAs. OR You can choose 2 & 3 - tax deferred accumulations and tax-free distributions. But then your contributions are not deductible. Can you think of any type of retirement vehicle with these features? Right! A ROTH IRA! Of course, Tax-Free Municipal bonds share some of these characteristics (depending on state law) and interest from tax-free muni-bonds are a tax preference item to calculate whether your social security is taxable or not. But what might surprise you is that Life Insurance also shares these tax benefits. (We can look at a more detailed analysis of each of these three, if you wish.)
  • We always think of life insurance as “death insurance” – cash to your family when you die. But with cash value life insurance, in addition to providing that protection for your family: 1) The premiums are paid with after tax dollars 2) The policy generates cash value, that generally accumulates on a tax-deferred basis 3) And you can access the policy cash values – before or during retirement – generally on a tax-free basis if structured properly – and I will help you do that. AND - upon your death, when many other investments are taxed, your beneficiaries receive the death benefit income tax free
  • Best of all, life insurance can be a self-completing plan. You see, there are only three things that will happen to you between now and retirement: (1) You will LIVE; (2) you will become DISABLED; or (3) you will DIE. A cash value life insurance policy can provide peace of mind and cash in all three scenarios. If you live… You enjoy all the “living benefits” of life insurance, including the potential for tax-free retirement income and then Your family receives a death benefit when you die, If you become disabled… With the Disability Waiver of Premium Rider, your premiums are waived, and all the benefits of your policy stay in force If you die… Your family receives the full value of the policy, less any unpaid loan and loan interest, income tax free
  • Let’s assume that you want to have $90,000 per year for retirement income. (it could be a lower amount $50,000 or $60,000 and work the same way). If all that income is taken from a qualified plan, such as a 401(k) or Traditional IRA, then it is all taxable income to you, if your filing status is married filing jointly or a qualifying widow(er) and would put you in a 25% marginal tax bracket under today’s federal income tax rates. If you tax diversify so that you could pull half the income from a tax-free source, such as cash value life insurance, then only half of the $90,000 would be taxable and in this example would lower your marginal bracket from 25% to 15%. (Assumes that combined with other sources of taxable income, adjusted gross income does not exceed income maximum for 15% tax rate.)


  • 1. Tax Diversifying Your Retirement Income This presentation includes a discussion of one or more tax-related topics. This tax-related discussion was prepared to assist in the promotion or marketing of the transactions or matters addressed in this material. It is not intended (and cannot be used by any taxpayer) for the purpose of avoiding any IRA penalties that may be imposed upon the taxpayer. Taxpayers should always seek and rely on the advice of their own independent tax professionals. Please understand that New York Life Insurance Company, its affiliates and subsidiaries, and agents and employees of any thereof, may not provide legal or tax advice to you. 00386186CV Exp. 12/2010
  • 2. Retirement Isn’t What It Used to Be
    • Once:
    • Retirement typically lasted about 10 years
    • Social Security, defined benefit pensions and some personal savings covered basic expenses
    • Now:
    • Retirement can last longer
    • Many key sources of income have been reduced
    • Increased reliance on personal assets
    Social Security Pension & Qualified Plans Personal Assets Social Security Pension & Qualified Plans Personal Assets
  • 3. Social Security Is Shaky
      • Social Security was never intended to be the only source of income for retirement
      • The maximum Social Security Benefit in 2008 for a worker retiring at full retirement age was $2,185 per month 1
      • There are limits on how much you can earn before your Social Security benefits are reduced and/or taxed
    1 Fast Facts & Figures about Social Security, 2008, SSA Publication No. 13-11785, Released: August 2008; page 2 Without changes, by 2041 the Social Security Trust Fund will be exhausted* and there will be enough money to pay only about 75 cents for each dollar of scheduled benefits. * These estimates are based on the intermediate assumptions from the Social Security Trustees’ Annual Report to the Congress. “ ”
  • 4. Fewer Pensions, Limits on Qualified Plans
    • Only 22% of today’s workforce has access to a defined benefit pension plan 1
    • Fewer employer contributions to pension plans; limits on company matching of 401(k) plans 1
    • More reliance on employee contributions
    • Limitations on contributions
    1 ‘ Trends in Retirement Plan Coverage Over the Last Decade,” Monthly Labor Review , Stephanie Costo, February 2006. Pensions & Qualified Plans
  • 5. Personal Assets Are Critical
    • Most people have more questions than answers when it comes to planning for retirement
      • How much will I need?
      • How much will I have?
      • How much do I need to save to cover the shortfall?
    • For personal savings, the questions are:
      • Where should I put my money?
      • How will I be affected by taxes?
    Personal Assets
  • 6. Tax-Perfect Retirement Planning
    • The “tax-perfect” retirement plan would include:
      • Contributions that are tax deductible
      • Accumulation that is tax deferred
      • Distributions that are tax free
    • Such a plan does not exist, but you can have any two of these tax benefits
  • 7. Where Do You Think Taxes Are Going?
    • Tax rates are currently at historically low levels, suggesting they may be higher when you retire
    • Tax-diversifying your retirement savings might be sensible
    The graph above illustrates the high and low marginal tax rates over history. Exemptions, deductions and state and local taxes are not taken into account when illustrating these marginal tax rates. Your actual tax rates may vary from those show on the graph. Remember that historical rates are not a guarantee of future rates. Source: U.S. Department of Treasury, Internal Revenue Service, Statistics of Income, Historical income Tax Returns (2008)
  • 8. Is Tax Deferral the Best Strategy?
    • 30 years ago, tax rates were so high and there were so many tax brackets, deferring income generally reduced the tax burden
    • In the new tax reality, the tax leverage benefits of deferring may not exist
    • Lower tax rates and fewer tax brackets today call for a smarter strategy
    1979-1980 2009
  • 9. Your Retirement Savings Tax Options Roth IRA Tax-free municipal bonds Cash value life insurance Traditional IRA 401(k) Pension plans Profit-sharing plans Keogh Financial Vehicles After tax Tax deferred Tax free Tax deductible Tax deferred Taxable
    • Tax Treatment
    • Contributions
    • Accumulation
    • Distributions
  • 10. A Non-Traditional Solution 1 The cash value in a life insurance policy is accessed through policy loans, which accrue interest at the current rate, and cash withdrawals. Loans and withdrawals will decrease the total death benefit and total cash value. Life Insurance
    • In addition to protecting your family, cash value life insurance can provide an ideal way to tax-diversify your retirement savings
      • Premiums are paid with after-tax dollars
      • Generates cash value that generally accumulates on a tax-deferred basis
      • Allows you access to policy values – before or during retirement – generally on a tax-free basis 1
    • Upon your death, when many other investments are taxed, your beneficiaries also receive the death benefit income tax free
  • 11. A “Self- Completing” Plan!
    • If you live…
      • You enjoy all the “living benefits” of life insurance, including the potential for supplemental tax-free retirement income
    • If you become disabled…
      • With the purchase of the Disability Waiver of Premium Rider, your premiums are waived, and all the benefits of your policy stay in force 1
    • If you die…
      • Your family receives the full value of the policy, less any unpaid loans and loan interest, income tax free
    1 Available on whole life policies Social Security Pension & Qualified Plans Personal Assets
  • 12. The Benefits of Tax Diversification Retirement Income of $90,000 Without Tax Diversification $90,000 401(k)/Qualified Plans 100% taxable $90,000 taxed at 25% 1 = $22,500 tax Tax Diversification Strategy $90,000 $45,000 401(k)/Qualified Plans 100% taxable $45,000 taxed at 15% 1 = $6,750 tax $45,000 . Cash Value Life Ins. tax free 2 $45,000 taxed at 0% 2 = $0 tax 1 Marginal federal income tax bracket under current rates. 2 If structured properly. $67,500 to spend after taxes $83,250 to spend after taxes